Mikhail Vnuchkov · Follow
13 min read · Feb 27, 2024
Proprietary trading is a great way to start trading without much capital, but there is a considerable risk of losing money. Your success rate reflects how well you can handle the risks. In this article, we discuss the potential risks associated with proprietary trading (also called prop trading), analyze how prop firms operate, and weigh the potential rewards and drawbacks for traders.
A few risks associated with prop trading are:
— Poor performance — this is a common risk that is inherent to any form of trading
— Financial loss — the deposit of prop traders is not insured
— Risk management — prop firms have strict risk management guidelines
— Profit-sharing — profits are shared between the trader and the prop firm
— Ongoing performance monitoring
Prop trading firms allow vetted traders to get exposure to various markets, including stocks, currencies, commodities, and derivatives, using the company’s capital. The profits are then shared between the company and the trader based on predetermined conditions. Why would prop trading firms rely on independent traders rather than using in-house resources? The answer is simple: this business model gives financial firms access to talent while eliminating the need to pay salaries and reducing regulatory responsibilities. On the other hand, traders can initiate large positions with the company’s funds to benefit from potentially hefty profits.
As a rule, a prop trading firm is a big financial institution that engages in trading stocks, currencies, and other assets. Proprietary trades are generally speculative and conducted through a series of derivatives or other complex investment instruments.
To succeed with prop firms, traders should consider the following aspects and steps:
Recruitment and evaluation — prop firms tend to recruit skilled traders that can prove their status or evaluate the capabilities of traders through a demo or live account activity over a specified period while meeting certain performance goals. This evaluation helps the firm assess the trader’s skills and risk management abilities before providing access to the company’s capital.
Recruitment and evaluation — prop firms tend to recruit skilled traders that can prove their status or evaluate the capabilities of traders through a demo or live account activity over a specified period while meeting certain performance goals. This evaluation helps the firm assess the trader’s skills and risk management abilities before providing access to the company’s capital.
Capital allocation — once a trader succeeds with the evaluation, the company allocates a specific amount of capital for the trader to use. The trader can use leverage to place larger trades and potentially generate higher profits. Note that prop traders have to deposit a certain amount to be used as risk contribution. This will cover any losses incurred and may be depleted entirely if the trader doesn’t generate enough profit to offset losses.
Risk management — prop firms have strict risk management guidelines that all traders must follow. This can refer to stop-loss limits, maximum drawdowns, and position-sizing rules, among others.
Profit-sharing — profits generated from trading activities are shared between the trader and the prop firm according to a predefined profit-sharing arrangement.
Ongoing performance monitoring — prop firms continuously monitor the performance of their traders to ensure they maintain a high level of competence and adhere to the firm’s risk management guidelines. Underperforming traders may face the consequences, such as reduced capital allocation or termination of their trading privileges.
Giving proprietary funds to skilled traders enables prop firms to generate hefty profits from various trading opportunities in the Forex market and other financial markets
The fact that prop traders don’t use personal funds doesn’t minimize risks. So how are prop firms risky? Here are a few aspects to know about:
- Poor performance — this is a common risk that is inherent to any form of trading, especially when using high leverage. Even if you perform well during the evaluation process, you may end up losing funds due to market volatility, poor trading decisions, or economic events that take you by surprise. Losses negatively impact a trader’s profit-sharing agreement and, in extreme cases, result in the termination of trading privileges.
- Financial loss — the deposit of prop traders is not insured and may be exposed to fraud and other business risks. This is due to loose regulation, which is why prop traders usually deposit what they can afford to lose — a rule that you should always stick to.
- Strict risk management rules — prop firms impose strict risk management guidelines to protect their capital. While these rules help financial companies preserve their assets, they can sometimes limit a trader’s flexibility in executing trades. This often results in missed opportunities or forced exits from potentially profitable positions.
These are some of the basic risks that you should be ready for with any prop firm. The risk of losing funds due to poor performance may be amplified by the constant pressure to perform well, a burden that many traders cannot handle consistently.
If you perform exceptionally well, you’re prone to another type of risk that has to do with intellectual property. Specifically, some prop firms may decode your unique strategy, which could reduce its success rate in the long term.
How much can you make as a funded Forex trader?
The short answer is yes — you can actually lose 100% of your deposit used as a risk contribution, and sometimes more than that.
Let’s discuss a few examples of how prop traders can lose funds and see the potential extent of these losses in each case:
Poor risk management — if you fail to implement proper risk management techniques, for example, by neglecting the appropriate stop-loss orders, you may end up losing a significant portion of the allocated capital. In some cases, this could lead to the loss of the entire trading account, depending on the severity of the market move and the leverage used.
Unforeseen economic events — the Forex and stock markets are susceptible to volatile moves due to unexpected economic events, such as central bank interventions or geopolitical developments. Prop traders can face significant losses if they have open positions during such events. For example, during the 2015 Swiss Franc crisis, when the Swiss National Bank unexpectedly removed the EUR/CHF peg, many traders ended up with substantial losses incurred within minutes. In such cases, losses can exceed the trader’s account balance, potentially putting them in debt to the prop firm. In this particular case, you can lose more than your deposit.
Emotional decision-making — prop traders can lose money due to over trading or making impulsive decisions driven by emotions Such behaviors can lead to a series of losing trades that eventually deplete the trader’s capital rapidly. In this scenario, a trader can lose a significant portion, if not all, of their allocated capital.
In each of these cases, the amount a prop trader can lose depends on the specific circ*mstances, the size of the trading account, and the risk management rules set by the prop firm.
In 2012, the Swiss banking giant UBS surprised markets when it announced losses of $2.3 billion caused by unauthorized speculative trades conducted by Kweku Adoboli, who operated alone. Adoboli’s trading activity can be treated as a form of prop trading, even though he apparently had the status of an employee.
What is Prop Trading? Top Pros and Cons
Though often considered risky for very good reasons, prop trading is among the most lucrative activities carried out by financial institutions. A prop trader’s earnings typically hinge on a pre-established profit-sharing ratio, with the actual amount earned relying on factors such as commissions, negotiations, profitability, and trading volume. Consequently, the potential earnings are limitless.
Profits from trades are generally divided between the firm and the prop trader; however, the risk distribution is asymmetric. This means that in the event of a loss, the trader bears 100% of the losses, while they don’t receive 100% of the profits. Most prop trading companies retain 10–25% of the total profits and allocate the remainder to the prop trader. It’s important to understand that trading, particularly day trading, is highly volatile, implying that one could make or lose millions within the same timeframe.
How Much Does the Average Day Trader Make?
To minimize risks in prop trading, consider the following recommendations:
Choose a reputable prop firm — pick a well-established prop firm with a proven track record and positive feedback from traders. Feel free to check our list of the Best Prop Trading Accounts Compared in 2024.
Develop a robust trading strategy — you should stick to a trading plan that considers risk management principles, such as position sizing, stop-loss orders, and maximum drawdown limits.
Keep emotions under control — trading can be emotionally taxing, but it is crucial to keep your emotions in check and make decisions based on objective analysis rather than fear, greed, or overconfidence.
Monitor your performance — make sure to assess your trading performance and identify areas for improvement.
Prop trading is fully legal, although many of the prop firms allowing remote trading are not regulated at all. Since prop firms trade using their own capital and are not considered providers of financial services, they do not fall under the purview of regulatory bodies, thus operating legally without having to comply with strict rules.
This lack of regulation means that prop traders also don’t need licenses. Moreover, prop firms generally do not mandate any specific educational background or previous experience. Their primary concern is a trader’s ability to generate profits.
Understanding the ins and outs of a funded account is crucial before you dive into trading. If you lose money, the repercussions can vary significantly based on the type of account and its governing rules. Let’s delve into the possible scenarios.
A large number of funded accounts operate under a maximum drawdown rule. This rule sets the ceiling on how much money you can lose. Cross this limit, and you risk losing your trading privileges in that account. Essentially, if you can’t manage risk, the firm will manage you — by terminating your account.
In some rare cases, you might find funded accounts that cover your trading losses. In such situations, you don’t have to reimburse the losses from your pocket. This feature is more common in institutional settings, and it serves as a cushion for traders. But don’t let this safety net lure you into risky behavior; these accounts often have stringent performance metrics that you must meet.
Proprietary trading firms often provide evaluation accounts where you prove your trading skills. Usually, you pay a one-time fee to enter this “challenge.” If you lose money during this evaluation, you won’t owe anything beyond the initial fee. However, failure may mean that you have to pay another fee to retake the challenge or look for opportunities elsewhere.
Violating account rules can lead to swift consequences. Overstepping drawdown limits or breaching other terms can result in the closure of your account, often by the end of the trading day. This immediate action protects the firm from further losses but leaves you without a trading platform.
Prop firms frequently set daily loss and overall drawdown limits. Once a trader hits these limits, they may need to cease trading for the day or even face account suspension. This strategy curtails significant losses and safeguards the firm’s assets.
Holding positions overnight brings its own set of risks, including market gaps and sudden news events. To mitigate these, prop firms limit the size of positions that can be held after market hours. This move further helps in reducing the scope for big losses.
Every trader in a prop firm must adhere to a set of stringent risk management rules. These can range from using stop-loss orders to abiding by position-sizing constraints. Following these rules ensures traders don’t take excessive risks and thereby protects the firm’s capital.
In a prop trading setup, both the trader and the firm share the profits based on a predefined ratio. This arrangement motivates traders to manage risks judiciously, as their income is tied to their trading performance.
Prop firms deploy advanced risk monitoring systems that track traders’ activities in real time. These platforms analyze various metrics to gauge profit, loss, and overall exposure. Instant monitoring allows for quick intervention to resolve potential issues.
Risk limits don’t remain static. They are periodically reviewed to align with current market conditions and the firm’s risk tolerance. Usually, senior management or a designated committee handles these reviews, ensuring that the set limits still serve their purpose effectively.
For firms that adopt a challenge-based model, traders must meet specific profit targets within a defined time frame to qualify for a funded account. Although this adds an element of pressure, it also serves as a measure of a trader’s ability to succeed under actual trading conditions.
Your capital is at risk.
SurgeTrader offers a 75% profit split to funded traders who meet their trading criteria. It’s the perfect prop firm to diversify your investment portfolio with a variety of tradable assets. SurgeTrader has only one phase of evaluation, unlike many other prop firm trading entities that require traders to pass several levels of evaluation.
Traders can choose from six packages. With the Starter Package, you get $25,000 in instant funding and a 10% profit target. There’s a maximum trailing drawdown of 5% allowed. The Starter Package is ideal for beginners who want to avoid overly aggressive trading. With a $1 million funding size and a 75% profit split, the Master Package is the highest-tier account. A 10% profit target is set, along with a four-percent daily loss limit and a five-percent maximum trailing drawdown allowance. If you have a lot of confidence in your abilities, then this package may be for you.
This prop firm offers a wide variety of tradable securities, including crypto and gold, as well as popular stock indices. It’s possible to access leverage up to 1:10.
A top proprietary trading firm, SurgeTrader requires all of its clients to undergo evaluation. You need to pass only one phase of the SurgeTrader Audition process. It’s not necessary to earn over 10% of your account balance in order to pass the audition
Audition fees range from $200 to $6,500 per account. There’s no limit to how many times you can take the audition. You can use credit/debit cards and PayPal to make payments and withdrawals.
Your capital is at risk.
With its brand power and reputation as an industry innovator and one of Inc 5000’s fastest-growing companies, Topstep has earned the trust of many traders. To participate in the funded account program, all traders begin with the Trading Combine. You can open a real-time simulated futures account with $150K, $200K, or $300K buying power.
During the Trading Combine, you can earn a funded trading account if you demonstrate consistent profitability and manage risk appropriately. Using Topstep’s capital, you can trade in real time without personal financial risk, with funds provided by Topstep.
As quickly as within eight trading days, traders can qualify to receive a funded account (the amount of funding provided is determined by the Trading Combine plan).
The first $5,000 in profits you make can be withdrawn in full, and 90% of profits exceeding that amount can be withdrawn.
With Topstep, payout requests are processed on a daily basis (payout requests made prior to 10 a.m. CT are processed on the same day).
Topstep’s trader development services include instruction from professional traders, tools, and daily live videos, along with personalized analytics on performance and bonuses for traders.
Trading platforms supported include TSTrader, TradingView, NinjaTrader, Sierra Chart, MultiCharts, R|Trader Pro, and many more.
For a $50k account, Topstep pricing starts at $165 per month. $100k accounts cost $325 per month, and $150k accounts cost $375. Free trials are also available for 14 days.
Best Funded Trader Programs Compared
Your capital is at risk.
With more than 6,000 traders worldwide, Fidelcrest has a strong reputation. The company offers performance coaching, million dollar account sizes, and up to a 90% profit split. During a limited time, Fidelcrest is also offering three bonuses, including a second chance challenge, fast track qualification, and double assets.
With Fidelcrest, you can trade real capital, with the industry’s highest profit split. Fidelcrest will invest real money after your two phases of evaluation. In terms of tradable assets, Fidelcrest also stands out. In addition to Forex, you can also trade, commodities, indices, and stock shares.
Fidelcrest is one of the prop firms that pays you a commission during the evaluation process. You can receive up to 50% of your earnings after you pass the second evaluation stage. As a funded Findelcrest trader, you’ll make an additional 80–90%.
The number of account options Fidelcrest offers is unmatched by any other company. There is an account that will meet your needs regardless of your risk tolerance, trading strategy, level of experience, or budget. There are three types of accounts: Pro Accounts, Aggressive Accounts, and Micro Accounts. You can open an account with funding of $10,000, all the way up to an account worth $1 million.
The most common risks of prop trading are inherent to the trading process itself. For example, the dangers of Forex trading spill over to your prop trading activity. On top of that, you should be ready for risks associated with strict risk management requirements, constant pressure, emotional trading, and fraud.
Prop trading is worth it, although it’s not recommended to invest more than you can afford to lose. Prop trading is suitable for beginner traders who don’t have enough capital to start their journey.
Prop firms usually make between 15% and 50% of each trader’s profit, plus additional fees for opening an account and using the software. Thus, they’re most often in the money as they don’t cover losses.
It is estimated that only 4% of Forex traders succeed with prop firm challenges, and only 1% of traders can generate profits consistently without violating any rules.
